Protecting your estate in a high-tax state

By Glenn Ruffenach

The federal government giveth–and state governments taketh away.

Everett Collection

To keep it in the family, you’ll have to get creative.

That’s increasingly the case with estate and gift taxes. The current federal estate exemption—the amount of a deceased person’s estate that isn’t subject to tax–is $5.25 million per individual. But some states have far smaller exemptions. (The figure is just $675,000 in New Jersey.)

What’s more, some state legislatures–in a never-ending search for revenue–are tightening the rules. Connecticut, in 2011, lowered its exemption to $2 million from $3.5 million. This year, Delaware rescinded a plan that would have allowed its estate tax to expire, and Washington state raised its top rate on the largest estates for 2014.

Don’t get burned by changing rules. Congress, when it changed the estate-tax rules in January, retained so-called portability rules, which allow a surviving spouse to claim a partner’s unused federal estate-tax exemption. Before portability rules were enacted, such unused exemptions could have been lost if a couple hadn’t set up a special “credit-shelter” trust.

The point: Such trusts are still necessary in many states with estate taxes. Yes, assets will pass tax-free to a surviving spouse if there isn’t a trust – but at the second death, a couple could lose the value of one of their two state exemptions, says Linda Hirschson, an estate lawyer at Greenberg Traurig in New York.

Consider making gifts. Giving cash and noncash assets to family members and others can be one of the most effective ways to minimize estate taxes–especially since most states don’t have a gift tax and the federal exemption is so large. One caveat: Choose carefully if the gift isn’t cash. The reason: The “cost basis” of a gifted asset carries over to the recipient, which means they could face a hefty tax bill if they eventually opt to sell the asset.

Be careful with out-of-state property. Some states subject second homes (read: summer and vacation homes) to their estate tax even if you live in a state without death duties. It might not be possible to apply the state’s entire exemption to shelter your property.

Moving to another state? Do it right. Yes, you can pull up stakes and move to avoid estate taxes. But changing one’s “domicile” involves more than spending time outside a state. Other factors to consider: where a taxpayer votes; owns property; belongs to clubs; registers a car; has a professional license; or has a burial plot.

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About Encore

Encore looks at the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities, needs and priorities of people saving for and living in retirement. Our lead blogger is editor Matthew Heimer, and frequent contributors include editor Amy Hoak, writer Catey Hill, and MarketWatch columnists Elizabeth O’Brien, Robert Powell and Andrea Coombes. Encore also features regular commentary from The Wall Street Journal retirement columnists Glenn Ruffenach and Anne Tergesen and the Director of the Center for Retirement Research at Boston College, Alicia H. Munnell.